Last Update, July 26th, 2016. Mortgages are classified by their repayment style and how interest is charged. When you borrow money to buy a car or for a new kitchen, you repay the loan over, perhaps 3 to 5 years. To buy a home, most people have to borrow amounts so large that it needs repaying over a much longer time.
25 years is the standard repayment timeline. Most mortgage providers offer loans for longer, or less time if you ask. Mortgage companies will want the mortgage paid back by the time you retire (they usually assume this to be at 60 or 65 years old) as they assume you can only repay the mortgage while you are in full time work. If you are older than 40, the maximum mortgage length they will give you, would be retirement age minus your current age. So for a 46 year old male, this is 65 minus 46 = 19 year maximum mortgage term.
Before you search to find a mortgage, it’s useful to use a mortgage calculator and get an idea of repayment costs for borrowing different amounts of money. When you use a mortgage calculator, first use the interest rate you expect to start on (you’ll get this when you look for mortgage deals, keep reading for that). Then enter an interest rate that is 1%, 2%, 3% and 5% higher than the rates being offered to you now. Why is this? Well even if you lock into a fixed rate interest policy, eventually interest rates will go up (fixed rates only last for a few years). When they do the cost of repaying the mortgage can go up by a Huge amount! So you must ensure you can afford repayments if interest rates jump to 7% or 8%. At the moment interest rates are at their lowest, so the only way is up! That means you need to provision for paying more in future months to repay your mortgage. I can’t stress this enough – interest rates will go up and you need to be comfortable paying that extra amount per month. This means the monthly payment you begin with should not be stretching you at all – it should be very comfortable.
Who offers mortgages?
Banks or building societies provide mortgages. They offer different mortgage types and interest rates depending on: what suits them; how much money they have to lend; how much profit they are trying to make. It is unwise just to take a mortgage from whomever you bank with as they often won’t be the cheapest or have the best terms. Always shop around. Private banks can offer competitive mortgages to those looking for larger amounts. Should you be looking for a mortgage over £750,000 it is wise to ask around the smaller private banks as they can be more flexible on these larger amounts. As they like to lend to their own customers, you may have to switch your other banking to them.
Who has the Best deal?
You can view the individual websites of banks and buliding societies, or pop into their branches for a leaflet to find out their current mortgage rates and deals. This is quite time consuming so we suggest three alternatives.
First, read through the guide below so you understand all the options. Then, have a think about which mortgage might suit
you best (it’s ok if you’re not sure). Now, goto the comparison websites such as Money Supermarket or Compare the Market.
These sites keep upto date with the different mortgage offers from most of the providers and show who is offering the best deals.
When you have a few ideas, we suggest you consider contacting a mortgage broker or IFA (independent financial advisor). This isn’t always necessary, however if you’re still lost when you’ve searched the above sites, they are qualified to provide financial advice. By explaining your circumstances to them they will be able to sift through the many mortgages on offer and find a deal which best suits you. Ask your broker if they cover ‘whole of market’ – this just means they look at every deal on offer. If they are not, walk away.
Finally, goto this site: Money Advice Mortgage Finder. This independent, unbiased site is approved by the financial regulator and will allow you to search across the mortgage market.
Mortgage Brokers / IFA’s
Brokers get paid a percentage (0.5% to 1% of the mortgage they obtain for you) by the mortgage provider. Some will also charge you a fee directly. Ask upfront about fees. If they do want you to pay, they must tell you straight away. If you do want to use a broker that charges you a fee, always hold back payment until completion – i.e. wait until the mortgage is being used before paying the finders fee. When speaking with brokers you are trying to evaluate if their fee is going to be recovered because they find you a cheaper mortgage. In this case you must be comfortable with your broker – if you don’t trust them or feel remotely uncomfortable, walk away – there are hundreds of other brokers to speak to. Before committing to using a broker, ask them for some examples of mortgages and costs, then say you will get back to them in a few days. Now go onto the internet to the sites mentioned above and check those mortgages – are they at interest rates that seem cheap? If so, you can feel more confident that the broker is doing his job properly.
5 of the biggest mortgage lenders either don’t entertain brokers or don’t offer them commissions. Hence it’s unlikely your mortgage broker will advise you to get a mortgage from one of these providers (brokers should be unbiased, but they’re not!). The big 5 are:
HSBC, First Direct (who are owned by HSBC), ING direct, Britannia and Yorkshire. Personally I have found all of these firms offering some very good mortgage deals – in fact they are often the most competitive, so check their websites against any mortgage a broker offers you. If you aren’t sure, call them up and explain the best mortgage you have been quoted and ask if they have something similar at a better price.
Mortgage brokers must be registered with the financial regulator: the FCA [Financial Conduct Authority, formerly known as the ‘FSA’], or be agents for firms ‘authorised’ by the FCA. FCA standards require firms to be competent, financially sound and to treat their customers fairly. Brokers and mortgage providers following FCA guidelines have to give you ‘Keyfacts’ documents which are in a standard format to make comparing different mortgages easier.
You can read what the Government has to say about using brokers by clicking here.
Make your own checks
Unfortunately some brokers or firms claim to be FCA authorised, when they are not. Unless the broker belongs to a well known firm that has been around for a long time and advertises their service throughout the UK, it is best to double check they are real. Here are some links to help you:
Click here to see the FCA guidelines on protecting yourself.
Even with mortgage advisors being registered, do check what they have told you by speaking to the bank or building society they say has the best mortgage for you. Call or visit them directly, explaining the mortgage your broker has advised you take and asking what they think. They can’t give you advice but they may suggest another mortgage. Also take the mortgage your broker suggests (e.g. 5 year fixed interest, offset mortgage) and check the details and costs against comparison sites (listed above), or phone around a few banks.
A Simple Test:
If the 5 year fixed offset the broker advises, is at an interest rate of 3.8%, does someone else have a 3.5% deal?
If so, why are you being recommended the more expensive one?
Are you being advised to go with a mortgage that requires an upfront payment to the bank / building society?
If so, does another provider offer the same rate with no upfront fee?
Brokers can be very useful, but they are human, so they often suggest deals which get them a higher commission. You can use them to obtain a mortgage, just check their advice and don’t believe everything they say. Alternatively, do enough research on your own and you can save yourself some money.
Should you be self-employed, not have a first-class credit history, or be a non-normal borrower (e.g. you aren’t a British national, you work abroad, this is a second home) brokers can be invaluable as they have better contacts and know who to approach that would be open to lending to someone in your circumstances. In this case you should call around a few brokers, explain your circumstances and ask how many people they deal with in the same situation. Next, ask which mortgage companies are lending to the type of customer you are (e.g. self employed) and examples of rates. You are testing here if they respond quickly and confidently. If not, they may well just be leading you on to get business, when they are not a specialist in your area.
Still need help finding a broker? Email us at: info@LondonAndProperty.com and we’ll do our best to help.
Mind your credit rating
If you speak to several mortgage companies do not ask them all for a mortgage approval – this is when you give them your financial information and they tell you if they will lend to you and how much. Filter down to the 2 best mortgage deals then apply to the banks / building societies. Should they reject you, or a better deal comes along you can apply to another provider. It’s best not to apply to more than 2 if you can help it. Why? Each time you apply for a mortgage or loan (e.g. for a car) the financial company performs a ‘credit check’ on you.
Each time a credit check is performed, this is recorded by the credit agencies. Should you apply for several mortgages at the same time, mortgage companies will see that there have been several checks on your credit status recently – but will not know why. They often assume something suspicous is happening – for example you think you won’t get a mortgage so are applying to as many providers as possible. Avoid looking suspicious – apply to only one at a time, or 2 maximum.
Once you have found the best deal and have applied for it, you are looking to be granted ‘mortgage approval’ or an ‘agreement in principle.’ These give you a level of certainty – although not a guaranteed mortgage. An estate agent and seller will value you more if you have this in place, over someone that has to get their mortgage in place once they have found a property to buy. It also confirms your property purchase budget is accurate (i.e. you can borrow as much as you would like to) and you can review the monthly repayments you will need to make. Decide if they are comfortable – remember to calculate what you would pay when interest rates rise.
Most of us understand ‘Simple interest.’ For example if the interest rate on a mortgage is 5% per year. This simply means if you borrow £500,000 for your mortgage, you will have to pay £25,000 in interest per year. Each month you will also have to repay part of the money you borrowed (if you have a repayment mortgage). As you repay each month, the amount outstanding reduces and overall you are paying less interest (if the interest rate has stayed constant) and more of the principal (the £500,000 in this case).
A.P.R. interest. When looking at mortgages (or any loan) the interest is often quoted as ‘A.P.R.’ interest. All this is doing is rolling up any additional fees charged outside of the interest into one interest rate. So APR just means the simple interest plus any other costs, shown as an interest rate. If you have simple interest of 5% and a mortgage arrangment fee of £2,000 and other admin fees of £200 the APR may be 5.2%. So APR just lets you compare the true cost of borrowing for each mortgage, rather than having to work it out yourself.
Interest rate moves – watch out!
Currently interest rates are extremely low. It’s unlikely they will go any lower, so it’s the cheapest time to borrow money. This also means if you borrow money now, your repayments are only going one way in the future – UP! The reference mortgage providers use is known as the interest ‘base rate’ and is set by the Bank of England. Mortgage providers charge borrowers more than the base rate, so they can make a profit. If you take out a mortgage now, a 3% jump in interest rates, which could happen in as little as a couple of years, could double your monthly repayment!
Given wage growth (how much salaries rise by each year) is low and inflation is quite high (prices of food, petrol and clothes keeps rising) this could mean you are stretching yourself or unable to repay if interest rates rise. To guard against this, you can take out a ‘fixed rate’ mortgage, described below.
Interest rate types
Floating & SVR
Typically mortgages were always ‘floating.’ This means the interest rate the mortgage company charges you moves up and down when the Bank of England change the UK base rate. It does not mean the changes occur at the same time. Your mortgage company can increase your interest rate early, if they think the base rate will be going up soon. If the base rate drops, they are not obliged to drop their rate at the same time.
Often mortgage-lenders reduce their rates with a lag-effect, when the Bank of England reduces rates. Sometimes they only reduce by part of the rate cut, i.e. the base rate comes down half a percent, yet the bank only reduces your mortgage interest rate by a quarter of a percent. Other times they may not reduce at all! Given the bank retains control over how their rate moves, it is only loosely ‘floating’ with the base rate and is hence often referred to as SVR or standard variable rate.
For those who want the certainty of always moving with the base rate (even though you won’t be able to predict how the base rate will move), tracker rates fix the interest rate you pay at a level above the base rate and promise to always have the same difference. If base rate is 1% and the tracker is +2% then it will always remain this and banks will have to adjust quickly when any rate changes occur (not neccessarily on the same day).
Sometimes these tracker rates are combined to limits on how high (interest rate cap) or low (interest rate collar) the rate can move. The limits usually only apply only for a fixed time period. Tracker rates have typically been closer to the Bank of England base rate than the Floating or SVR rates.
To entice you into a mortgage and help out with the first few months of home ownership, many banks offer a discount for a certain period on their floating or SVR rate. First time buyers often like these deals – just ensure you can cope with the repayments when the discount period ends, especially if interest rates have moved up – there could be a bigger jump in your monthly payment than you expected. Buying a home that will need new furniture, decoration or refurbishment? A discounted rate can help keep monthly payments down while you pay for these in the first few months, or help if you need to rent elsewhere while works are carried out.
Fixed rate mortgages offer the same interest rate for anywhere from a year to 10 years (2 to 5 years are most popular). You pay a premium over the current rates available on tracker or SVR mortgages. Part of this premium is used by the bank to protect themselves from increases in the interest rate, when it goes above the rate you are paying. If you need to ensure your monthly outgoings are very stable then take this option. Especially at the moment while the base rate is at the lowest its been, you can benefit from the cheapest monthly payments over a number of years.
Mortgage repayment styles
Most buyers take out a repayment mortgage which is also known as capital and interest repayment. Each month your mortgage payment goes towards paying the interest on the loan and paying back the money (capital) borrowed. At the start of the mortgage most of your monthly repayment is paying off the interest. After a few years the small capital payments each month reduce the money outstanding and more of the monthly payment is going towards repaying what you borrowed, less of it is paying the interest.
Interest only mortgages mean you don’t pay each month anything towards paying off the capital borrowed. The monthly repayment is much cheaper as you are only paying off interest – therefore you need to make provisions for how you will pay back the actual money borrowed. Previously buyers took out an ‘endowment’ which was an investment designed to pay off the mortgage. Unfortunately, many of these didn’t create high enough returns and at the end of the mortgage there wasn’t enough money from paying into that investment to pay off the bank.
Because of this buyers and banks usually avoid this method of repayment now. If you want an interest only mortgage you will have to convince the bank that you have a sure fire way of paying them their money back after 25years (or however long you borrow it for). Just promising to save the extra money up in a savings accounts, ISAs etc, is not enough.
Generally interest only mortgages are best avoided unless you have very special circumstances (a trust fund due to mature in the future for example). The interest rate you are charged for this type of mortgage will probably be higher as the bank sees you as higher risk than someone paying back part of the money borrowed each month. If you can only afford your mortgage by taking out an interest only deal, then you can’t afford that property!
A relatively new style of mortgage, they pick up some of the void left by genuine buyers who wanted an interest only mortgage, not because they had an investment to pay off the borrowed money, but because they have uneven earnings or want more financial flexibility. Offset mortgages allow you to have a Savings and Current account which matches off against your mortgage borrowings. So if you borrow £500,000 and you have £150,000 in a savings account plus £10,000 in a current account (as long as they are ‘linked’ to the mortgage account) you are only charged interest on £340,000.
Essentially an offset is an interest only mortgage, so again, the bank will want a very good idea of how you intend to repay the money, so you don’t just make the interest payments each month. The negative with offset mortgages is they offer you increased flexibility at a higher price: the interest rate is normally higher than a repayment mortgage from teh same lender. Offsets are useful to people in 3 types of circumstances:
Employees who get lumpy bonuses or sales commissions in addition to their salaries like offset mortgages as it allows them to pay off chunks of the mortgage when they get their bonus and use more of their salaries for other living costs during the rest of the year. Business owners who pay themselves a ‘dividend’ or share of profits every year can also make one off large payments into offset accounts, rather than paying smaller sums every month to pay off the mortgage.
Should you have a large amount of money in savings, offsets are ideal as you will only pay interest on the net amount (mortgage amount minus savings). As the interest rate you pay to borrow money is much higher than the interest you are paid on savings (thats how the banks make money) an offset allows you to reduce your expensive debt. Of course you lose any interest on your savings, but as you are not paying the more expensive interest on your borrowings, you win. Remember interest earned on savings is taxed at your personal income tax level, so you are earning even less – or by using an offset, that money is effectively earning you a much higher level of interest by being offset against your borrowings.
Should you wish to pay off your mortgage early, many lenders will charge a large fee on their normal mortgages. With an offset you can simply put all the money in the savings account and you effectively have no mortgage. You can also take that money out again (and restart your interest payments) if you need to, rather than just closing out the mortgage.
Do you have some savings that you might want to use in the future, yet maybe you won’t? Perhaps you have a good size savings account, but you might want to use some of that for a new car in a years time. Or a new kitchen. Maybe you like to have some cash on hand in case you need it for a rainy day, your business, or for investments. Offset mortgages allow the ‘offset’ in two ways. You can either overpay into the actual mortgage account and reduce the debt permanently. Better still, just put the extra money into a linked savings account then should you find a better use for it, you can always pull the money back out – no penalty. And while those savings are offsetting, you are saving a fortune in interest.
Family Help Recently a new type of offset mortgage has been offered, which allows your families savings to reduce your mortgage interest. Say your parents have some savings which they are keeping in the bank and don’t intend to use. There are now offset mortgages where you can take out a mortgage and your parents can place their savings into an account, linked to your offset, which will reduce the amount you have to pay interest on. Relatives receive security as you can’t access or spend their funds and they retain flexibility as they can withdraw some or all of their money any time they want. Of course while that money is in the linked account, every penny is reducing the interest you pay on your mortgage saving you hundreds or more likely, thousands of pounds.
Special Tip: If you take out an Offset, by far the best advice is to pay more than the interest monthly. Have your direct debit payment pay off some of the principal each month, not just cover the interest. Then when you have more money to put in, you can leave that in the savings account to pull back on it. This way if the big bonus doesn’t come through, or you delay a business dividend for a year, you know you are sill reducing your overall debt.
Lenders need a deposit from you, to prove you are financially responsible. Previously you could get a 100% mortgage (no deposit) or even a 125% mortgage (no deposit and money to pay for stamp duty and fees). Unfortunately too many borrowers over extended themselves, property prices went down, repayments weren’t made and mortgage lenders were left with properties worth less than the money they had lent for them.
These days financial prudence is the name of the game. It’s probably impossible to find a mortgage with no deposit. With just a 10% deposit there are a few mortgages available, yet most lenders will want you to put down 20-25% of the property price in deposit (remember you still need other money for stamp duty and fees).
With deposits, the more you have, the less you pay on your mortgage. What do we mean? The higher percent deposit you have, the cheaper the interest rate you will be offered by the lender. So those mortgages with only 10% deposits will have very high interest rates – perhaps 2% or 3% more than the banks best rate. On a £500,000 mortgage, the higher interest rate as a result of only having a 10% deposit could add £150,000 to your total interest cost over 25 years – wow!
Usually lenders offer a mortgage with their worst interest rate for a 20% deposit. Above a 30% deposit the interest rate improves. 40% deposit and above is usually the cheapest rate you will get… from then on the bank needs to keep their profit margin so even if you have a 70% deposit the interest rate won’t get any cheaper.
Some lenders charge upfront fees for a mortgage. This can be anywhere from £500 to a few thousand pounds. Many of the lenders will also offer a slightly higher interest rate with no upfront fee. Always check the APR rate, to compare the true cost of the mortgage. Sometimes paying the upfront fee makes sense and is cheaper in the long run.
Early repayment penalty
Lenders like to know that you will be repaying your mortgage over the time you have said you will. So for most people, 25 years. When the lender has this reassurance, they work their magic in the background and do anything from hedge (protect) the interest rate they have given you, to selling on your mortgage debt to someone else. You will never know about this, yet most lenders will act in some way behind the scenes. As a result, if you wish to repay your mortgage early, this can leave them with a problem, because they have taken some action on the loan which they can’t unravel. Accordingly most mortgage providers will charge an early repayment fee, which is usually very high – so high you are often better putting the money into a savings account until you can repay without a penalty.
Of course mortgage lenders want to prevent you just closing the mortgage with them because you have found a better deal elsewhere. If you kept closing and moving your mortgage to a new provider every six months it would cause mayhem for the banks and building societies. So the lenders are partly trying to keep you a loyal customer. The important thing is to check the mortgage terms and conditions and see how much the early repayment penalty is and how long it lasts. It won’t be in place the entire life of the mortgage, the penalty is usually there if you want to pay off the mortgage in the first few years.
When you compare mortgages or your broker gives you the best deals, be sure to ask about early repayment penalties and how long they are in effect for. It may mean you take the mortgage with a slightly bigger upfront fee to give you flexibility in the future. Remember early repayment is not just for lottery winners or investment bankers, you may want to repay early so you can move your mortgage for a better deal.
You can read more on early repayment on the Financial Ombudsman website by clicking here.
You may wish to consider mortgage payment protection policies which covers your mortgage payment each month should circumstances change so that you can’t. Rather than explain what we think about mortgage protection insurance, we’ll direct you to a very good guide written by the Which? consumer group: click here for their guide.
Also consider taking out life insurance policies if you haven’t already. If you buy a property and something happens to one of the contributors to the mortgage, it could mean the rest of the homes occupiers (often your family) can’t meet the mortgage payments. Life insurance policies are often taken out to offer peace of mind. Always shop around and don’t just take a policy from your mortgage provider because it’s convenient.